In a recent revenue procedure (Rev. Proc. 2016-40), the IRS provided two safe harbors for determining if a distributing corporation has control, within the meaning of Section 368(c), of a controlled corporation immediately prior to bring about an otherwise qualifying Section 355 spinoff.
Prior to this guidance, it was uncertain whether a taxpayer could recapitalize into a structure that met the statutory definition of control, but then unwound the equity structure after the spinoff. For example, if the distributing corporation owned only 70% of the controlled corporation but then recapitalized into two classes of stock — high vote and low vote — to achieve control under Section 368(c), the question remained regarding the point at which the distribution corporation could undo that structure of high-vote and low-vote stock.
The first safe harbor under the revenue procedure states that a later unwinding is acceptable if it occurs after 24 months from the spin-off date, provided no action was taken (including adopting a plan or policy) to bring about the unwinding by the controlled corporation's board of directors or management, or the controlling shareholders before that 24-month period expired.
The second safe harbor is if the unwinding is caused by an unanticipated third-party transaction (even if within the 24-month period referenced previously) provided that there was no agreement, understanding, arrangement, substantial negotiations or discussions within the 24-month period before the date of the spinoff and no more than 20% of the interest in the third party is owned by the same person who owns 20% or more of the controlled corporation (taking into account attribution rules).
The effective date of the guidance is Aug. 1, 2016, but the safe harbors may be applied retroactively.
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